Anthony Hilton: Theresa May is wrong to be rigid on EU departure date

Britain will leave the European Union in March 2019

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15 November 2017

Someone must have told the Prime Minister it would be a good idea to write into the Bill before Parliament that, whatever happens, we would leave the EU at 11pm on March 29, 2019, exactly two years after Article 50 had been triggered. No doubt it was seen as yet another easy concession for the ideologues she seems unwilling ever to confront.

Unfortunately, it is not painless; it is potentially disastrous.

If the Bank of England, the Department of Justice or the Treasury had been asked to comment in advance they would surely have understood and forcibly pointed out that, paradoxically, the setting of a fixed date is a cause of further uncertainty. But there was no sign of any consultation. Downing Street is winging it once again in seemingly blissful ignorance of the consequences.

Joe Egerton, someone with more than 30 years’ experience working in financial regulation and a former Oxford academic, has mapped out some of these consequences in an article on the website of The Conservative Group for Europe. It is scary stuff because it explains that the key implication of having a fixed date is that it draws a line which marks the legal ending of all existing ties. That in turn means absolutely every financial contract has to reflect the new reality from that moment, which obviously means it all has to be sewn up beforehand.

Every last bit of outstanding business — every derivative and insurance contract will have had to be reviewed and, if necessary, modified, re-drafted or scrapped before that date so it will still be legally enforceable in the brave new world. It is a task of gargantuan complexity.

Bank of England deputy governor Sir Jon Cunliffe told the Lords EU committee that there are now more than £110 trillion of derivatives out there which were written on a cross-Channel basis, only £70 trillion of which are with clearing houses. There are also masses of other financial products, insurance policies and the like.

There has always been a risk that something could go wrong with all this stuff as Brexit unfolded but until this latest hare-brained move it was always assumed there would be some flexibility around the date of leaving, so that solutions could be patched together.

This flexibility was a comfort as there are grave doubts in regulatory circles whether the banks can handle all this stuff on their own in the time available, particularly as resources in big law firms are now also overstretched.

But there was no serious panic because it was assumed there would be enough give around the date to delay things long enough to ensure all the key bits of wiring were in place before the Government threw the switch. With a fixed date that assumption is shattered: a legally binding date removes that latitude.

The consequences of moving before everyone is ready could be dire. It would create uncertainty around the validity of at least some of these derivatives contracts which would of course seriously impair their value.

That, in turn, will have an impact on bank balance sheets, possibly a large one given the huge nominal sums involved. No one will know who is affected and to what degree and that uncertainty could be toxic because it will affect the willingness of banks to lend to each other. Once that happens you are on the downwards escalator towards a banking crisis.

We saw in 2008 what happens when banks start to worry about the financial health of other banks, how small concerns rapidly escalate and the whole system freezes up with everyone worried about everything else. As Cunliffe also said before the committee: “Sub-prime losses of $360 billion (£270 billion) turned into $2.7 trillion worth of losses for the financial system, in part because those losses knocked banks over and once you start knocking banks over you get credit drying up and that knocks more banks over.”

Contract uncertainty in derivatives has the potential to provoke a re-run of the 2008 crisis. Sticking this date in for no good reason is playing with fire in a petrol station.

Most people reading this will think derivatives are nothing to do with them. They should not be so complacent. There is a derivative behind almost every fixed-rate mortgage, or any financial product with a guarantee. People need to appreciate that these things strike very close to home.

Insurance is another potentially affected area. UK insurance companies will overnight become unable to pay claims from non-UK customers elsewhere in the EU and vice versa. A surprising amount of motor insurance is arranged cross border, with many Brits having policies which have originated in the Republic of Ireland to say nothing of seemingly British companies that actually do their business through Cyprus and elsewhere. The biggest mainstream insurer of small businesses in the UK is generally believed to be Allianz, a German company.

These policies will be fine until the cut-off date, but many will have to be re-negotiated or replaced before then. That is irritating, probably costly but feasible. But claims are a different matter. If a policyholder had made a claim while the policy was still in force but the cheque in settlement had not arrived before the cut-off date it would cause a massive problem because any such payment would become illegal once we leave the EU and so the claim could not be settled. Perhaps the Foreign Secretary Boris Johnson will again suggest they should “go whistle” for the money.

There is much more to worry about in the Egerton paper but what it brings into focus is the wisdom of an idea floated by Sir Howard Davies, a former regulator and now chairman or RBS.

He argues that we cannot go on drifting aimlessly towards disaster. Instead he thinks the Government should empower a group of financial professionals — “wise persons” — who actually understand this stuff.

It must allow them to draw on the best brains and expertise from across Europe to work out all the mind-numbing technocratic detail of how to handle this stuff, and how actually to achieve the nuts and bolts of co-ordinated regulation.

Only the technocrats can avert a train crash now and even for them, time is short. The politicians not only need to get out of the way, they need to understand how little they understand about the real world, so they stop making things worse with their silly political games.

Abandoning that unnecessary deadline would at least indicate that the Prime Minister is beginning to get it.

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